Ninth Circuit Affirms Denial of Discharge under Section 727(a)(3) for Chapter 7 Debtor's Failure to Keep Financial Records

By Andrew Toth-Fejel, Bankruptcy Litigation Support for Attorneys, Andy@BLSforAttorneys.com

Caneva v. Sun Communities (In re Caneva)
Ninth Circuit Court of Appeals Case No. 07-15686
November 5, 2008

This Ninth Circuit opinion filed yesterday addresses the standard for denying discharge under § 727(a)(3) of the Bankruptcy Code, regarding a debtor's failure "to keep or preserve any recorded information, including books, documents, records, and papers, from which the debtor's financial condition or business transactions might be ascertained, unless such act or failure to act was justified under all of the circumstances of the case."

Facts & Procedural Context

The individual Chapter 7 debtor Caneva listed on his personal property schedule fifteen business entities in which he held an interest, and stated: "[t]he extent of his interest and the status of several of the entities is unknown. The debtor has made his best effort to list all he knows and if additional information becomes available, additional amendments will be made." At a Rule 2004 Examination by creditor Sun Communities

Caneva admitted that he kept no records for the entities, despite the fact that some of them had business operations and others existed as holding companies for active businesses. Caneva also admitted during the Rule 2004 Examination that he had no documentation regarding the payment of $500,000 to Bowden as a brokerage fee for a $20 million loan that Caneva stated he did not receive, although he indicated that Sun could contact the Federal Bureau of Investigation for details on Bowden’s criminal prosecution and conviction.

Sun Communities filed an adversary proceeding to deny Caneva's discharge under § 727(a)(3), and the bankruptcy court granted this creditor's motion for summary judgment denying discharge. This decision was affirmed by the U.S. District Court, and Caneva appealed.

Holding

Under 11 U.S.C. § 727(a)(3) the creditor has the burden of

establishing a prima facie case (1) that [debtor] had failed to keep or preserve records and (2) that such failure made it impossible to ascertain his financial condition and material business transactions. The prima facie case shifted to [debtor] the burden to avoid summary judgment by showing that a genuine issue of material fact existed with respect to whether his failure was justified under the circumstances of his case.
. . . .
[T]he statute imposes an affirmative duty on the debtor to keep and preserve recorded information that will allow his creditors to ascertain his financial condition and business transactions. A debtor who has admitted to owning businesses for which he kept no recorded information and to transferring a substantial sum of money without retaining any documentation has not kept or preserved information within the meaning of the statute, and must provide a justification for this failure that goes beyond a conclusory statement in an affidavit that he is entitled to discharge.

The Court's Rationale

1) The Failure to Keep Records: The Prima Facie Violation
The Court relied heavily on its own earlier opinion, Lansdowne v. Cox (In re Cox), 41 F.3d 1294 (9th Cir. 1994), in stating the elements of a prima facie case, and then the burden on the debtor to justify the failure to keep records, quoted above. Debtor argued that he had turned over to the creditor and the trustee boxes of his records, and these documents, together with the public criminal record on the conviction of his broker, were sufficient to create a genuine issue of material fact about the adequacy of his records for § 727(a)(3) purposes. The Ninth Circuit disagreed. It adopted the Seventh Circuit's assertion of "an affirmative duty on the debtor to create books and records accurately documenting his business affairs," and the requirement that if a debtor is sophisticated and owns a business with substantial assets "creditors have an expectation of greater and better record keeping." The Ninth Circuit focused on "the crucial point that the total absence of records related to his business entities and to his alleged $500,000 payment to Bowden necessarily makes it impossible for Sun to accurately determine his financial condition and business transactions."

Thus, we hold that when a debtor owns and controls numerous business entities and engages in substantial financial transactions, the complete absence of recorded information related to those entities and transactions establishes a prima facie violation of 11 U.S.C. § 727(a)(3). Likewise, we hold that when a debtor transfers a substantial amount of money to a third party, the failure to keep any documentation evidencing the terms of the transfer or the fact that the payment actually took place establishes a prima facie violation of 11 U.S.C. § 727(a)(3).

2) The Burden on Debtor to Justify His Failure to Keep Records
After the creditor established its prima facie case

Caneva could have avoided summary judgment by presenting evidence sufficient to show that a question of material fact did exist as to whether such failure was justified under the circumstances of his case. Aside from a conclusory statement tracking the language of § 727(a)(3) in his affidavit in opposing summary judgment, however, Caneva made no effort to present evidence tending to show that the business entities for which he admitted no records existed were of the type that would not generate records. Likewise, he has not presented any evidence that might justify his failure to keep records regarding the $500,000 payment to Bowden.

After noting that the standard for justifying a debtor's failure to keep records depends on "whether others in like circumstances would ordinarily keep them," the Court said

the only explanation that Caneva has submitted that purports to justify his failure to keep or preserve such records is the statement in his affidavit that the circumstances of his business dealings justified the absence of any records he did not possess. He did not disclose the so-called circumstances of his business entities.

Since "a conclusory statement in an affidavit that an absence of records is justified is not enough to avoid summary judgment," the Court affirmed the lower courts' denial of debtor's discharge.

The Bottom Line

To avoid successful challenge to their discharge under § 727(a)(3), a debtor must keep and preserve sufficient documents about her business and financial affairs to enable creditors to accurately determine her financial condition and business transactions. And if such business and transactional documents were not kept or preserved, debtor must have an objectively sound justification in order to preserve her discharge.

by: Andrew Toth-Fejel
Bankruptcy Litigation Support for Attorneys
Andy@BLSforAttorneys.com

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